Four Types of Tax Audits and Tax Compliance. Nothing is surer to elicit feelings of panic than receipt of a letter from the IRS and for good reason. Tax issues and penalties can have harsh and sometimes long-lasting impacts on an individual or business’s financial health. While some letters or notices aren’t cause for much concern, an audit notice should not be taken lightly. All audits are not created equal and some are more alarming than others. There are ultimately four types of IRS audits that you could receive.
1) Correspondence Audit
The first of the four types of tax audits are correspondence audits are the most common type of IRS audits. In fact, they comprise roughly 75% of all IRS audits. Correspondence audits are the simplest type of audit and involve the IRS sending a letter in the mail (typically a 566 letter) requesting more information about particular part of a tax return. For example, the IRS may have questions regarding auto expense and request you send in receipts to substantiate your deduction.
Another correspondence you may receive instead of a 566 letter would be notice CP2000. If the information you provided in your tax returns doesn’t match what the IRS has on record for your account, a CP2000 notice will be sent notifying you that the IRS is proposing an adjustment for under or overpayment of tax obligations. You will need to respond with whether or not you agree or disagree with the notice. If you disagree, you will need to provide supporting documentation and return the form within 30 days from the date of receipt. If you agree and owe money, you will need to submit payment to the IRS immediately or request a payment plan.
You should never ignore a letter requesting information if you receive one, as doing so will only aggravate what should otherwise be a simple correspondence. If you prepared your tax return correctly and you have the source documentation (receipts, invoices, payments, etc.) to back up the items on your return, a taxpayer can generally handle correspondence audits on their own and likely won’t have to meet with an IRS agent in person. Simply providing the requested documentation should put the matter to rest.
If a you are missing receipts or documentation, then you may want a professional dealing with the IRS to assist you in resolving the matter. There can always be fines, penalties, and interest if there is an increase in tax due at the end of the audit.
2) Office Audit
The second type of audit is an Office Audit. If the IRS has questions about your return that are too complex or large for a correspondence audit, but too small for a field audit, you will get a letter in the mail requesting that you come into an IRS office for the audit. Generally speaking, an office audit is more detailed and may have more issues. Office audits typically surround issues pertaining to itemized deductions (Schedule A), business profits/losses (Schedule C), or rental income/expenses (Schedule E). Often one issue with a schedule can trigger an audit, but audits can quickly expand if the auditor suspects there may be problems in other areas of the return.
The office interview will consist of questions related to the issue under examination. There may also be more generalized questions about employment, financial position, and lifestyle in an attempt to find other causes for concern (like the possibility of underreported income). An individual should give careful consideration to the answers and documentation provided to the IRS. It’s very easy for a taxpayer to unintentionally give the auditor a reason to expand the scope of the audit.
Auditors are well-trained tax professionals who are very good at getting nervous taxpayers to provide damaging information. It is in your best interest to seek legal advice from a tax attorney before an office audit. An office audit with the IRS will typically conclude after just one day. If the Agent wants additional information, they will give you time to supply the necessary information.
3) Field Audit
A field audit is the most comprehensive of the four types of tax audits and detailed IRS audit. It involves the IRS visiting the taxpayer at their home or place of business to examine records. Field audits are performed by IRS revenue agents, who are generally more skilled and knowledgeable than most other IRS representatives. IRS revenue agents will also often specialize in a certain industry.
When the IRS visits a home or place a business, they may ask to see things outside of certain records. They do not want to limit themselves to a particular item. A typical audit for a business includes a review of financial records, interviews with employees, and a tour of the business facility. Interviews will be used to ascertain an overview of management structure, accounting procedures, and internal controls. For an individual, the audit will just consist of a review of financial records and an interview with the taxpayer. The audit could last anywhere from one day to a week, depending on the complexity of the account.
Field audits are by far the most intrusive and serious form of audit. If you’ve been selected for a field audit, you should retain the services of a tax attorney who can be present at the time of the audit. Anything you say can be used against you to expand the scope of an audit. A tax attorney can communicate with the auditor on your behalf to ensure the scope is not accidentally expanded.
4) Taxpayer Compliance Measurement Program (TCMP) Audit
The fourth type of audit is a Taxpayer Compliance Measurement Program (TCMP) Audit. The primary purpose of this type audit is to update the data for the IRS’ DIF scores. DIF scores are developed from analyzing a large group (involving up to 50,000 randomly selected returns) of intensive audits, conducted every few years. In a TCMP audit, the IRS will analyze every item on the tax return and every part of the return must be substantiated by documentation. A standard audit is time consuming in that a taxpayer must find checks, invoices, contracts, bank statements, etc. for the items selected for audit. In a TCMP audit, every line of the tax return is audited therefore you have to provide documentation for all deductions not a selected few items.
Whichever audit you may be confronted with, it is always best to get organized and stay calm. For instance, pull all your canceled checks, receipts, and other information related to the items to be audited and get that information in sequential order.
The Importance of Seeking Legal Advice
Due to their inexperience with the IRS, individuals have a tendency to provide too much information to IRS Agents, which may ultimately harm them. Experts advise bringing in a tax attorney to assist in resolving an audit. A tax attorney will provide only the limited requested information to the agent/auditor in an organized manner, which limits the amount of information that is exposed to IRS scrutiny.
If you’re facing an IRS audit in California, learn more about the four types of tax audits and tax compliance with our team of attorneys at RJS Law are available to help. Our team may be able to limit the scope of the audit and can negotiate with the IRS on your behalf. Contact our San Diego, Los Angeles, or Orange County office by filling out a contact form or calling to receive a complimentary consultation.
Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law.